Round 1 of distributor regulations over

The first step towards regulating mutual fund (MF) distributors has been taken. The Rs. 7.68 trillion Indian MF industry has successfully mapped about India’s top 370 distributors (by way of commissions received from selling MFs) by doing their due diligence.

Over the past year, India’s top MF distributors were grilled by one or two of the 11 auditors that the Association of Mutual Funds of India (Amfi) had appointed to inspect the records, books and practices of these MF distributors, as per the guidelines laid down by the capital market regulator, Securities and Exchange Board of India (Sebi), through a circular issued in August 2011.

This first-of-its-kind exercise that started in November 2011 got over in July 2012. If your MF agent happens to be one of them, your fund house is now in a position to keep a better check on him and how s/he sells you MFs, whether s/he understands your risk profile before suggesting you investments, and so on.

Distributor experience

It isn’t pleasant at times to get audited, especially if you’re not used to it. As per the Indian Companies Act, all companies need to be audited. Limited liability partnerships also need to get themselves audited. Independent financial advisors (IFA), whose turnover exceeds the minimum threshold limit that calls for a taxation audit, also need to undergo a simple audit of the books of accounts. However, most IFAs were never subjected to a rigorous audit of their operations and systems.

Which is why when such distributors were subjected to the due diligence process—a type of audit—it was a new experience for many. Most of the agents we spoke to, though, took it positively.

For Sapna Narang, managing partner, Capital League Pvt. Wealth Management, being part of the due diligence was a “good step”. “It will give confidence to investors. As the word spreads, investors will find confidence in dealing with MF distributors, especially those who are accredited after this process,” says Narang. With every passing year that this process will get repeated, she thinks, distributors will get more disciplined, which is good for the client as well as for the firm. Capital League is a boutique firm run by three women and it has just one office—in Gurgaon.

Also, since most of Narang’s clients are high networth investors (HNIs), she follows the advisory model wherein she charges her clients a fee for giving advice on their portfolios. Narang also maintains declarations from investors who insist on certain MF schemes that the firm thinks may not be suitable for them; a practice followed by few distributors. Besides, HNIs invest large sums of money and therefore are always know-your-customer (KYC) compliant. So, ready declarations and no KYC misses ensures that her auditing process is smooth.

Ahmedabad-based Ashish Shah, director, Wealth First Portfolio Managers Ltd, one of Ahmedabad’s oldest and largest MF distributors, says he “did his homework diligently” before the auditors landed up at his doorstep. Before the auditors visited the MF distributors, Amfi had already sent all distributors questionnaires that had queries about the various facets of their businesses. “I spent about four hours putting together everything in order as per the requirements before the auditors came to my office. The auditors were impressed by the speed with which they finished auditing us, which speaks a lot, I feel, about our homework,” says Shah. His audit lasted for three days over which his auditor checked, among many other things, telephone accounts of his conversations with some of his clients and receipts of brokerages and commissions received from fund houses.

Shah says that by checking commission receipts, smart auditors can catch if the distributor has passed on a percentage of commission to investors—a practice known as commission pass-back, which was banned by Sebi many years back.

Some distributors, predictably, had some unpleasant experiences. A Mumbai-based distributor, who did not wish to be named, claims that not all the auditors appointed by Amfi had knowledge on how a MF house and its distributors work. For instance, if distributors just gave MF schemes to investors who walk into their branches asking for specific funds (“execution only” relationship; the adviser offers only a product but no advice), a customer confirmation is required that s/he bought the scheme on his or her own accord even though the adviser may think it’s inappropriate. “If agents make customers sign this “in-appropriateness declaration”, s/he is going to turn suspicious,” this agent claims. But not fulfilling this requirement, this agent says, did not impress auditors, despite the awkwardness on the part of the distributor to get one.

Sometimes, he continues, clients come with requests like change in bank mandate and write, say, today’s date on the form. “But the same client may actually visit my office after, say, two days. More so, if s/he comes after noon, my office peon goes the next day to the fund house’s office since I live in a distant suburb and need to leave early to make it before the cut-off time (typically 3pm). In some cases, therefore, two to three days elapse by the time the distributor submits these requests to the fund house. In such cases, my auditor concluded that I failed in my responsibilities,” he says.

The foundation stone

In August 2011, Sebi felt the need to regulate distributors. As a start, it put the onus on fund houses to regulate distributors by laying down a four-point guideline to identify distributors that would be brought under the regulatory ambit.

It said that fund houses will need to evaluate distributors on various parameters, including their business models, experience, proficiency and their research techniques, how they evaluate MF schemes and then sell them to investors and so on. Fund houses have been told to conduct this due diligence when empanelling distributors and then subsequently once every year.

Sebi has laid out four broad parameters to identify distributors. A distributor who is present across 20 locations and/or has raised assets under management over Rs.100 crore across all MFs it has invested in and/or commission received above Rs.1 crore across industry and/or commissions received over Rs.50 lakh from a single fund, will come under the ambit of due diligence.

Then, Amfi came up with the idea of outsourcing the task to conduct due diligence to a few audit firms to ensure standardization, while ensuring that the responsibility for due diligence lies with the asset management companies. It finally appointed 11 firms including big ones like PricewaterhouseCoopers Pvt. Ltd and Deloitte to medium-sized firms like Malpani & Associates Chartered Accountants and S. Panse & Co Chartered Accountants.

“At the end of it all, the process was so exhaustive that we even got a few calls from other distributors who told us that they wished to get themselves accredited through this process, though they were not mandated,” says V. Ramesh, deputy chief executive officer, Amfi.

Once the audit firms made the reports, they were passed to fund houses that would maintain records of empanelled distributors. Ramesh tells us that there are plans to repeat this process every two years.

What should you do?

While distributor due diligence may not impact you—the investor—directly, it does sharpen your distributor’s internal operations. In other words, every time you speak to your agent, your conversation gets recorded, his or her advice gets documented and so on. These records are then scrutinized periodically to ensure that your agent has sold you the right fund in the right way.

“The due diligence process would mean that a distributor who goes through this has got an independent evaluation or endorsement of his investment advisory process. This would lead to a greater investor’s trust in the adviser,” says Nagpur-based financial planner, Ranjit Dani.

Coupled with the impending investment adviser guidelines that Sebi is expected to announce in 2013 and the setting up of a self-regulatory organization to govern MF agents, the due diligence process will reduce mis-selling and bring in greater transparency in the distribution space.